“State of Supply Chain”: Industry-Specific Stress Test

Posted by RapidRatings on June 29, 2020

New RapidRatings Stress Test provides early warning for Supply Chain Managers—there is still time to select suppliers with strong financial health.

In March, we ran our first stress test to model potential outcomes of COVID-19 on our clients’ portfolios of public and private suppliers, third parties, borrowers and other counterparties. Please see the first stress test for details on the methodology and results. In this second edition, we analyzed sector-specific impacts to help clients focus on those areas of their supply chain which exhibit potentially deeper and more prolonged impacts of the current crisis. Instead of applying a flat 15% revenue decline across all industries, which we did for Stress Test 1, Stress Test 2 was tuned based on analyst consensus views for 2020 revenue impacts for each industry; e.g., the range of revenue changes ranged from greater than 28% declines in Oil & Gas and Transportation to minor 3% increases in Biotechnology and Drugs & Pharma. This yielded a more nuanced view of the extent to which industries were likely to be impacted over the coming year.

When comparing Financial Health Ratings (on RapidRatings’ 0-100 scale), pre- and post-stress test we noted a 21-point average decline for the top 10 impacted industries. To contextualize the change in risk profile, we examine the Transportation sector average FHR , which dropped from 66 (“Low Risk”) to 34 (“High Risk”). The associated probability of default at each FHR is 0.05% and 1.78% respectively; representing an increase of 35x. What this suggests for supply chain managers is that while mitigation plans for the handful of High Risk Tier 1 suppliers may have been manageable pre-pandemic, the risks for a larger group of financially stressed suppliers (and the cascading effect on their Tier 2 and Tier 3 suppliers) requires a more expansive approach to measuring supplier financial health – and that the potential consequences for not doing so are greater.

As you can see from Figure 1 below, the percentage of companies in High Risk and Very High Risk grows from 22% to 47% over the one-year stress test period. Yet, while almost half of the over 38,000 public and private companies included in Stress Test 2 saw their FHR risk level increase, the good news is that about a quarter (26%) of companies maintained a Low Risk or  Very Low Risk profile. The takeaway for supply chain managers is that the weakening of suppliers can be anticipated in advance: There is time to work with critical suppliers collaboratively to address mitigation strategies as well as to identify suppliers – at other tiers of their supply chains and externally – with the resiliency to deliver as the disruptions continue.

Figure 1.

We now look at sector-specific results of Stress Test 2 in Figure 2. As discussed, while our initial stress test applied a flat 15% revenue reduction across all industries, the revenue percentage change (grey bars) in Stress Test 2 varied by sector.

While there is a direct correlation between the change in revenue and the change in risk, as represented by the FHR (red bars), we can see differences in the impacts on industries. For example, nine industries experienced declines in their average FHR between 17 and 23 points, but the revenue declines varied between 12%-31%. The Business Products & Services and Oil & Gas (Integrated) sectors experienced 19 and 21 point drops in the average FHR from declines in revenue of 12% and 31%, respectively. Conversely, the Oil & Gas (Producers) sector experienced a drop of only 11 points in the average FHR from a revenue decline of 28%.

We now look at impacts across various industries.

Figure 2.

Drugs & Pharma Industry

As the Drugs & Pharma sector is expected to be less impacted by the pandemic, a modest 3% average revenue increase was applied to the companies in this sector. However, despite the strength in the sector, there are laggards.

Prior to the stress test, Mylan and Allergan were High Risk companies with FHRs below 40.  As a result of the stress test, Mylan’s FHR improves into the Medium Risk level, while Allergan’s FHR remains High Risk. Out of the more than 500 companies in the Drug & Pharma sector, the biggest improvement in the FHR was 21 points, while the largest decline was 50 points. So, even in an industry that is expected to be less negatively impacted by the pandemic, exposing the extent to which partners and suppliers may pose elevated risks of disruption should still be a priority.

Airlines Industry

It’s no surprise that the Airline industry, a sub-sector of Transportation, is currently taking a financial pummeling with COVID-19. For this reason, the stress test applied a sharp 53% reduction in revenue for airlines, which led to a 47% of the companies to migrate from Very Low Risk and Low Risk to the High Risk and Very High-Risk levels. Even perennial stalwarts like Delta and JetBlue saw massive declines in their Financial Health. However, in the U.S., federal infusions of funding to keep major airlines afloat will create a moat to partially protect them from the impacts of COVID-19 on their operations. Overall, the airline industry experienced a 33 point average drop in the Financial Health Rating during the stress test. With far fewer planes in flight, Airline Tier 2 and Tier 3 suppliers (who supply the airlines and their suppliers) upon which the Airlines rely, are especially at risk.  With the prospect of federal funding remote for their critical suppliers, Airlines should engage in financial dialogue to determine how they can navigate turbulent times together.

Figure 3.

Retail Industry

Another industry that has been hit hard by the pandemic is Retail. However, companies that fall strictly under eCommerce see an uptick given the nature of shopping these days. Given that “brick & mortar” stores have been closed and have yet to fully reopen, the estimated revenue reduction for the Retail sector was predicted to be 11%. By contract, the Online Retailers sub-sector was estimated to experience a revenue increase of 15% in this stress test. Unsurprisingly, large department stores and fast fashion took the brunt of retail sector Financial Health declines amongst businesses having physical stores, with discount retailers seeing less of an impact. For example, TJX stayed a Low Risk company even with an 18 point decline in their FHR during the stress test. See below for a small sample size of top retailers across department store, discount, and eCommerce categories.

Figure 4.

Next Steps

This latest stress test provides needed clarity to drive decision making. While the stress test shows that there could be a doubling in those companies rated High- and Very High Risk across all industries, there are still a quarter of all public and private companies demonstrating resiliency in the face of the pandemic.

As Financial Health is a fundamental driver to a host of risk areas, supply chain managers should put plans in place to gain more FHR coverage in their supply bases, shift spend to stronger suppliers and work with those potentially weakening suppliers that must be maintained in order to help mitigate the challenges they will face. RapidRatings clients have leveraged our purely quantitative, predictive FHR to prepare for just this type of disruption. We encourage you to view Stress Test 2 as an early warning signal – the time to secure your supply chains is now.

A complete review of the stress test in report form will be up for download shortly. In the meantime, take a look at our COVID-19 Resource Center for more information. 






Topics: Supplier Risk Management, COVID-19